If the election is mostly about the economy (stupid!) then it is important to go over the record of the last four years.
The financial crisis
No doubt the most defining event in shaping the economy during Obama's presidency was the financial crisis. At the hight of the panic, when credit markets froze up in the last stages of the Bush government, Ben Bernanke walked in to argue that we "won't have an economy come next Monday" and things were indeed rather bleak.
World trade, world equity markets, production and employment were all falling as fast, or even faster than in the aftermath of the 1929 stock market crash.
However, authorities also learned from that episode, and a combination of drastic measures and interventions from the Fed and the Treasury, partly set in motion under the previous presidency of Bush, stopped the free-fall.
Why the recovery has been so slow
The simple but often overlooked fact is that the 2008 crisis was a financial crisis. Recoveries from financial crisis are usually protracted and slow, as the historic work of Reinhart and Rogoff has shown. It isn't hard to figure out why this is the case:
- A 40% crash in house prices wiped more than $9 trillion off households balance sheets, resulting in increased saving and less borrowing and spending in order to repair the damage to balance sheets (hence the term 'balance sheet recession'). Repairing balance sheet is a slow process.
- Monetary policy, the tool which normally gets us out of a recession, has almost no traction under these circumstances. Monetary policy works mainly though stimulating more borrowing (and hence spending), but when people prefer to pay off their debt despite record low interest rates this has virtually no effect on the economy.
- Reducing borrowing and spending by households can easily feed on itself and lead into a vicious cycle in which lower spending leads to lower output and investment and higher unemployment, further reducing demand and eroding confidence. This is especially true in a situation in which bank balance sheets are also vulnerable and asset prices are already falling. Since monetary policy is almost powerless to stop this, it's fiscal policy which has to take up the slack.
The stimulus wasn't a failure
While much of the immediate rescue after the financial crash can be credited equally to the Fed and the previous administration, the Obama government is responsible for the American Recovery and Reinvestment Act (ARRA), the $787B stimulus bill that tried to plug the hole left by the reduced spending by households.
How big a gap was left by private spending wasn't immediately clear. When the stimulus was drawn up, expectations were for the economy to slump of 3.8%. However:
Months later, the bureau almost doubled that estimate, saying the number was 6.2 percent. Then it was revised to 6.3 percent. But it wasn't until this year that the actual number was revealed: 8.9 percent. That makes it one of the worst quarters in American history. [Ezra Klein]
So the output gap (the difference between demand and productive capacity) was almost certainly much greater, and hence the stimulus was almost certainly too small, and for much of the public, it has been a failure. Here is Dough Holtz-Eakin, economic advisor to McCain in 2008:
"The argument that the stimulus had zero impact and we shouldn't have done it is intellectually dishonest or wrong," he says. "If you throw a trillion dollars at the economy, it has an impact. I would have preferred to do it differently, but they needed to do something."
Another economic advisor to McCain argued:
We would be in a measurably worse place if not for the stimulus. I don't think it is any coincidence that the great recession ended [i.e., the economy stopped contracting] at precisely the same time that the stimulus . . . was providing its maximum economic benefit. [robertnielsen]
(click to enlarge)
Apart from these opinions, there are both theoretical and empirical reasons to argue the same. In the type of balance sheet recession, where the private sector reduces spending to pay down debt no matter how low interest rates are, monetary policy cannot achieve much as it works mostly through stimulating demand for credit.
This leaves fiscal policy as the only instrument to prevent reduced spending to reduce output, employment and asset prices further and create a self-reinforcing feedback loop. These things should have been explained to the American electorate, as Richard Koo argues in the Financial Timesa day before the election:
But when the private sector as a whole is saving money or paying down debt at zero interest rates, the banks cannot lend the repaid debt or newly deposited savings because interest rates cannot go any lower. This means that, if left unattended, the economy will continuously lose aggregate demand equivalent to the unborrowed savings. In other words, even though repairing balance sheets is the right and responsible thing to do, if everyone tries to do it at the same time a deflationary spiral will result.
With record low interest rates and a large output gap, public borrowing is both cheap and there is little if any danger that increased public borrowing will "crowd out" private sector demand for credit. We can therefore expect that under these conditions, fiscal policy will be especially powerful, and this is indeed what the IMF has (somewhat belatedly) found.
But there was already a lot of empirical research arriving at the same conclusion:
America's top economic forecasters -- Macroeconomic Advisers, Moody's Economy.com, IHS Global Insight, JPMorgan Chase, Goldman Sachs, and the Congressional Budget Office -- agree that it increased GDP at least 2 percentage points, the difference between contraction and growth, and saved or created about 2.5 million jobs. [Foreignpolicy]
The effect of the stimulus on public debt is rather small. Not only because of the transitory nature of the stimulus, but also because it boosted production (and hence tax receipts) rather a lot.
(click to enlarge)
One often reads (or hears) about that magical 1980s recovery and indeed, all considered that recovery was faster. But that is hardly surprising. The recession that hit in the early 1980s was one provoked by the Fed raising interest rates to unprecedented levels (above 20% for a short while even) to snuff out inflation.
Well, inflation indeed receded rapidly, but 20% interest rates also provoked a rather severe economic crisis. However, the Fed could quickly reduce interest rates when inflation fell rapidly (and bond rates receded in tandem), hence the V-shaped recovery.
The supply side revolution that was supposed to happen never really materialized. The 1980s didn't see any uptick in productivity growth (that happened only from the mid 1990s) nor much of a rise in median wages. This is hardly surprising:
Since 1980, U.S. investment as a percentage of GDP was sliced in half, from nearly 24 percent to 12 percent, leaving the United States 174th in the world. The result was a dearth of real value added products and productivity. [Moneynews]
Much has been made of Reagan's tax cuts, military spending, and deregulation. Although there probably were some mild supply-side effects from the tax cuts and deregulation, the irony is that this combination of loose monetary and fiscal policy was rather Keynesian.
The 2008 recession was a rather different beast. No V-shaped recovery here as monetary policy has been impotent this time around as households preferred to lower debt rather than engage in new credit.
The difference between the two recessions can be put into perspective. The 1980s recovery, like any other normal business cycle recovery, was produced by the Fed lowering interest rate, spurring a borrowing spree that fuels demand. Below you'll see that this is indeed what happened after previous recessions, but the 2008 one is the exception:
(click to enlarge)
So we would argue that Obama got the macro policies mostly right. During a balance sheet recession in which the private sector pays down debt, the public sector has to step in to avoid the lack of demand feeding on itself and become a vicious debt-deflationary cycle like in the 1930s. This is also what kept Japan's economy alive after the (much larger) bubble deflated in the early 1990s. Contrary to popular myth, the stimulus was a success (and one of the largest tax cuts in American history). If anything, it was too small.
However, Obama's other economic policies are a mixed bag. We'll quickly review a few of these.
Many of his own advisers were against the bailout of General Motors and Chrysler, but Obama pushed ahead anyway. This could have gone badly wrong, but it didn't. It's unlikely there were alternatives available at the time though:
But in 2009 no lender would provide the huge "debtor-in-possession" financing that a reorganisation of the two would require. Bankruptcy meant liquidation. That would have wiped out local economies and suppliers just as the banks were being rescued. [The Economist]
Although this merits a much larger entry, it's probably Obama's biggest failure of economic management. The program to induce banks to reduce mortgage payments (and so keep families from losing their homes and prevent the inventory of foreclosed houses to put yet more pressure on the housing market) hasn't achieved much. The government could, and probably should have been much bolder, forcing banks to write down much more mortgage debt.
Also a distinctly mixed bag. Much money was pumped into loan guarantees for alternative energy, but how effective this has been remains very much to be seen. On the one hand, much of the criticism, zooming in on failures like Solyndra is a little overdone. Not all of these projects were going to be winners (otherwise they would have been able to get commercial credit on easy terms) and Solyndra in particular was victim to a radical fall in the price of conventional solar panels.
The goal of reviving America's industrial base and thereby creating more skilled manufacturing jobs for a deflated middle class and compete with China in industries of the future is laudable, but the early results aren't terribly promising. Battery powered cars are still not ready for prime time and solar panels are dominated by Chinese players. High-speed rail is laughable compared with what China has achieved over the same time frame.
Although early results aren't too encouraging, one has to keep in mind that a true verdict isn't immediately available yet:
Defense Advanced Research Projects Agency, which funded the development of network technology that later became the Internet. Gerald Ford's Energy Department funded demonstration projects and research into technology for extracting natural gas from dense shale rock; decades later, abundant shale gas has revolutionized America's energy supply. [Washingtonpost]
Anathema to some, but markets need to be regulated to perform their magic. This holds true particularly for financial markets, as these are plagued with information asymmetries, often deliberately created by one party to gain an opportunistic advantage.
However, the Obama response in the form of the Dodd-Frank act to reign in Wall Street is needlessly complex (2300 pages), and much of it has been blunted by lobbying. It's still better than nothing, but people like Simon Johnson bang the drum on its insufficiency at every occasion, especially the continued existence of financial institutions that are too big to fail.
Obamacare divides opinions. The left sees it as essentially similar as what Romney introduced in Massachusetts, and a necessary and big step toward universal health care coverage for all U.S. citizens. They also (justly) point out that healthcare is rife with market failures (for instance, the healthiest people have the least incentives to insure) and the American system was both by far the most expensive in the world while leaving many people out and delivering sub-par results for the money.
Whether it will contain or raise healthcare cost depends on who you read, and it's too early to have much empirical data. However, in Massachussetts, the very similar Romneycare has significantly reduced insurance premiums. From its implementation in 2006 through 2009:
the average cost of individual coverage grew by 14 percent across the country, but in Massachusetts, premiums fell by more than 21 percent. For family plans, the difference was even more stark: across the United States, premiums rose by around 13 percent; in Massachusetts, they fell by nearly 40 percent. [Robb Mandelbaum]
While the U.S. runs large deficits at the moment, these are simply necessary to compensate the reduced spending because households are deleveraging.
Some form of credible medium-term plan to deal with this is necessary. So far, Obama has not done much (apart from rhetoric and pleading for the end of the Bush tax cut for high incomes) to specify such a plan (but the same can be said for Romney).
However, in some quarters Obama is called a socialist, responsible for rampant public spending. That view is pretty hard to square with the following data:
(click to enlarge)
The little bump around month 16 for Obama is the temporary hiring for the census, something which so confounded Neill Ferguson.
There can be little doubt that the U.S. faced a severe financial crisis, which could have bombed the economy. The initial policy reaction to this has been competent and prevented much worse. There can also be little doubt that the recovery was slow, but that's largely due to the nature of the crisis. As monetary policy is impotent under these circumstances, fiscal stimulus was the right initial reaction, but political circumstances have caught short (and even somewhat reversed) that response, especially on the local and state level.
The Obama administration's industrial and housing policies are hardly a rousing success and its effort to reform Wall Street, while better than doing nothing, comes up far short. There isn't yet a credible plan to deal with the medium-term public finance problems either. All in all, we'd say it could have been a lot worse, but it also could have been significantly better.
In the end, there is also something else to keep in mind:
Every president faces two painful, immutable truths about the economy: First, he has far less influence over it than voters think. Second, even when his actions make a difference, it is often not felt until after he's left office, and not always in the expected way. [Washingtonpost]